Trade tensions amplify the global slowdown

August 23, 2019

Economies go through cycles of contraction and expansion. Right now, we are in the longest US expansion of modern times and growth is naturally starting to taper off. This slowdown phase could run for several months or even years before a recession comes to fruition, but trade tensions could well accelerate this time-frame…

Worldwide manufacturing PMIs are grinding downwards as can be seen in the graphic (50 is the line between contraction and expansion). But the deceleration is not being felt uniformly in every region. The US is still doing quite well and the Bloomberg consensus believes it will register 2.3% GDP growth for the year. Its economy is somewhat insulated from the reduction in global trade due to its strong domestic market. On the other hand, the export-dependent eurozone seems to be skating on thin ice. Germany, its largest economy is now officially contracting (it shrank 0.1% in Q2). July was the worst month in 7 years for its manufacturing sector, with the PMI free-falling to 43.2, and now experts fear that the malaise will spread into the service sector. The manufacturing downturn is already evident in job creation figures which have slowed to their weakest level in 5 years, posing a real threat to future consumer spending. Emerging Markets are also losing their footing. China’s economy has been inevitably slowing from breakneck growth,  but tariffs are indeed exacerbating this. Industrial output fell to a 17-year low in July.

Global Manufacturing PMIs

Source: Bloomberg, BIL

While current data does seem pretty ominous, we are sceptical as to whether it is bad enough to explain the historical anomaly, whereby $16 trillion worth of fixed income assets globally offer a negative yield (yields act inversely to prices, and this implies a mass exodus to the relatively safer realms of the fixed income world). Fears surrounding the future of global trade is one of the big factors denting confidence and amplifying investor pessimism.

For now, the situation shows no sign of improving. South Korean export data (a gauge of global trade) garnered a lot of attention on Wednesday, falling for the ninth consecutive month (down 13% year-on-year). Semiconductor sales slipped 30%, while shipments to China, the biggest buyer of South Korean goods, declined 20%.

Trade is first and foremost being impacted by the ongoing US-China dispute. So far, some $250bn worth of Chinese goods have been hit with tariffs. Levies of 10% on $300bn more are in the pipeline. The damage that this has inflicted on the global economy is clear for all to see, especially since demand from China, an export hotspot, has significantly weakened.

But this is not the only threat to trade. The US may soon turn its gaze to Europe: if proposed tariffs on car imports into the US materializes, this could be the straw that breaks the bloc’s back. Already, eurozone exports to the US have slowed dramatically from an 18% expansion in May to only 1.2% growth in June, not to mention a 20% contraction in raw material exports.

Wednesday’s figure was also influenced by a smaller-scale trade dispute between Japan and South Korea. In a row over wartime practices, the two have deleted each other from their respective ‘trade whitelists’ and South Korea’s pension fund has threatened to disinvest from Japanese companies. Japan supplies materials that South Korea uses to make chips and displays for global export. South Korea has 73% of the market for DRAM chips and more than 90% for organic light-emitting diode (OLED) displays.

Another key risk clouding the horizon is the ongoing unrest in Hong Kong. Part of the recent rally in safe haven assets such as gold, is thought to be the result of fears that the situation will escalate. Hong Kong’s primary purpose is as a trade, logistics and services hub for Asia. So, with its airport being stormed by protestors, risks are rising. Escalation could represent yet another tear in the fabric of global trade.

Indeed, the Damocles sword that hands over the global trading system as we know it, is hanging by a very thin thread.

Author: Group Investment Office